Key Takeaways
- • The Barclay Hedge Fund Index returned only 2.89% in 2014, substantially underperforming the S&P 500 (13.1%) and a 60/40 stock-bond portfolio over 3-, 5-, and 10-year periods—including the financial crisis period when hedge funds theoretically should have provided downside protection.
- • Despite mediocre performance and high fee structures, institutional capital continues flowing into hedge funds: investors added $1 billion in January 2015 alone and $88 billion throughout 2014, bringing total industry assets to over $3 trillion.
- • Investor interest in hedge funds has "continuously accelerated since the financial crisis" and "picked up during the past two years," according to Peter Laurelli of eVestment, contradicting the expectation that underperformance would trigger widespread capital withdrawals following CalPERS' 2014 exit from hedge funds.
- • The persistent capital inflow into an underperforming asset class reflects institutional investors' continued belief in hedge funds' value proposition of higher returns with lower risk, despite a decade of performance data suggesting otherwise.
Summary
Hedge funds posted their second consecutive year of lackluster performance in 2014, yet institutional capital continues to flow into the sector at an accelerating pace—a seeming paradox that underscores institutional investors' persistent faith in alternative strategies despite compelling evidence to the contrary.
The Barclay Hedge Fund Index gained only 2.89% in 2014, trailing the S&P 500's 13.1% return and the Barclays U.S. Aggregate Bond Index's 5% gain substantially. More troubling for hedge fund proponents: the industry has significantly underperformed a simple 60/40 stock-bond blend across three-, five-, and ten-year periods. This underperformance is particularly damaging to the hedge fund thesis because the ten-year measurement period encompasses the 2008 financial crisis—precisely the market dislocation that hedge funds are theoretically designed to mitigate. Yet they failed to provide meaningful downside protection during that calamity.
Despite this performance drag and the high fee structures that have enriched hedge fund managers, capital continues pouring into the sector. Investors deployed $1 billion into hedge funds during January 2015 alone and added $88 billion throughout 2014 (per eVestment data). Total hedge fund assets now exceed $3 trillion. The inflow contradicts expectations that CalPERS' 2014 withdrawal from hedge funds would catalyze a broader institutional exodus. Instead, Peter Laurelli, vice president for research at eVestment, notes that "investor interest in hedge funds has been continuously accelerating since the financial crisis" and has "really picked up during the past two years."
This disconnect between poor performance and continued capital allocation reflects the enduring appeal of hedge funds' core value proposition to institutions: the promise of superior risk-adjusted returns or downside protection. Despite a decade of data suggesting this promise remains unfulfilled, large institutional investors continue to allocate capital, suggesting either deep skepticism of passive alternatives or fundamental belief that future hedge fund performance will diverge from historical trends.
The Barclay Hedge Fund Index gained only 2.89% in 2014, trailing the S&P 500's 13.1% return and the Barclays U.S. Aggregate Bond Index's 5% gain substantially. More troubling for hedge fund proponents: the industry has significantly underperformed a simple 60/40 stock-bond blend across three-, five-, and ten-year periods. This underperformance is particularly damaging to the hedge fund thesis because the ten-year measurement period encompasses the 2008 financial crisis—precisely the market dislocation that hedge funds are theoretically designed to mitigate. Yet they failed to provide meaningful downside protection during that calamity.
Despite this performance drag and the high fee structures that have enriched hedge fund managers, capital continues pouring into the sector. Investors deployed $1 billion into hedge funds during January 2015 alone and added $88 billion throughout 2014 (per eVestment data). Total hedge fund assets now exceed $3 trillion. The inflow contradicts expectations that CalPERS' 2014 withdrawal from hedge funds would catalyze a broader institutional exodus. Instead, Peter Laurelli, vice president for research at eVestment, notes that "investor interest in hedge funds has been continuously accelerating since the financial crisis" and has "really picked up during the past two years."
This disconnect between poor performance and continued capital allocation reflects the enduring appeal of hedge funds' core value proposition to institutions: the promise of superior risk-adjusted returns or downside protection. Despite a decade of data suggesting this promise remains unfulfilled, large institutional investors continue to allocate capital, suggesting either deep skepticism of passive alternatives or fundamental belief that future hedge fund performance will diverge from historical trends.
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